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The Market Impact Puzzle

Author

Listed:
  • Albert S. Kyle

    (University of Maryland)

  • Anna A. Obizhaeva

    (New Economic School)

Abstract

Finding a universal market impact formula remains one of the most fascinating puzzles in finance. This paper reviews two possible approaches for imposing restrictions on this formula. First, restrictions can be obtained from a system of economic equations using trading volume and volatility, as suggested by Kyle and Obizhaeva (2017b). Second, restrictions can be derived using dimensional analysis and leverage neutrality, as suggested by Kyle and Obizhaeva (2017a). Except for the knife-edged case of the square root market impact function, additional assumptions related to market microstructure invariance are needed to apply the same market impact formula to all assets simultaneously. This results in a tightly parameterized universalmarket impact formula suitable for empirical testing.

Suggested Citation

  • Albert S. Kyle & Anna A. Obizhaeva, 2020. "The Market Impact Puzzle," Working Papers w0270, New Economic School (NES).
    • Handle: RePEc:abo:neswpt:w0270
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    Keywords

    Market microstructure; invariance; liquidity; square rootmodel; market impact; transaction costs; dimensional analysis; leverage neutrality; volume; volatility;
    All these keywords.

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